This article examines the economics behind Australia’s capital gains tax (CGT) discount, prompted by a recent policy debate about whether the discount should be reduced. It draws on a clip from an Australian Taxpayers’ Alliance (ATA) livestream on 5 February, featuring Adept Economics Director Gene Tunny in conversation with ATA Chief Economist John Humphreys.
The discussion goes beyond the usual political framing of “fairness” to examine how the capital gains tax affects investment, productivity, and long‑run wage growth.
Under Australia’s current system, individuals who hold an asset for more than 12 months are taxed on only 50 per cent of the capital gain when the asset is sold. Proposals to cut the CGT discount — for example, to 40 per cent, 30 per cent, or even 25 per cent — would significantly increase the effective tax rate on capital gains.
Although this might sound like a technical adjustment, the economic implications are substantial. A reduction in the discount would increase the tax paid on realised gains by a large margin, materially reducing the after‑tax return on many forms of investment.
It would affect the taxation of capital gains on a wide range of assets, including shares, although potential property-market impacts (e.g., possibly lower property prices or higher rents) feature prominently in the debate.
Because of the political implications, the government may “grandfather” existing investments, so the reduced discount applies only to newly acquired assets.
From an economic perspective, capital gains are one of three main forms of capital income, alongside interest and dividends. While Australia taxes these forms of income differently, they are all returns to saving and investment.
Changes to capital gains tax, therefore, affect the incentives to:
Because capital income plays a central role in financing new businesses, innovation, and capital deepening, CGT settings have implications that extend well beyond investors themselves.
A central theme of the discussion between Gene and John on the livestream is that capital and labour respond very differently to taxation.
Labour income is relatively inelastic: most people must work to earn a living. Capital income, by contrast, is highly elastic. Investors can:
As a result, taxes on capital tend to generate larger economic distortions than taxes on labour. Even small increases in the effective tax rate on capital can lead to disproportionately large changes in investment behaviour.
Australia’s weak productivity growth is a major economic challenge. Productivity growth depends on investment in physical capital, innovation, and new technologies — all of which require capital.
Capital gains play an important role in rewarding:
Reducing the after‑tax return to capital risks discourages these activities. Over time, weaker investment leads to slower productivity growth, which ultimately constrains real wage growth and living standards.
In this sense, capital gains tax policy is not just about investors — it is closely linked to the long‑run performance of wages across the economy.
A key economic justification for some form of CGT concession is the impact of inflation. Capital gains are typically measured in nominal terms, meaning they can reflect rising prices rather than genuine increases in purchasing power.
For example, if an asset rises in value purely because of inflation, taxing the full nominal gain effectively taxes an investor even though they are no better off in real terms.
The CGT discount partially compensates for:
Without such adjustments, capital gains tax can fall on so‑called “phantom gains”, distorting investment decisions.
The current CGT discount is a blunt instrument. An alternative approach is indexation, in which only real gains—gains above inflation—are taxed. Indexation was previously part of Australia’s tax system and offers greater economic precision.
A further refinement discussed in the livestream is to adjust for inflation plus a normal real return, taxing only above‑normal returns or economic profits.
In economic terms, the “normal return” is the minimum return required to persuade households to defer consumption and invest their savings, distinct from above‑normal returns or economic rents, which can be taxed with fewer efficiency costs.
There is significant support in economic theory for not taxing (or only lightly taxing) the normal return to saving and investing, on the grounds that such taxes discourage capital formation and impose high efficiency costs.
Each approach entails trade-offs among simplicity, accuracy, and political feasibility. The key economic point is that well‑designed CGT should avoid taxing normal returns to saving and inflationary gains.
Capital gains tax reform is often justified on revenue or equity grounds. However, CGT revenue is volatile and highly sensitive to behavioural responses.
Moreover, capital gains realised in a single year are added to taxable income and can already be taxed at high marginal rates. Further reducing the discount raises questions about whether the efficiency costs outweigh the revenue benefits.
Politically, adjusting CGT is often seen as easier than reducing high marginal income tax rates, but the economic consequences may be more significant.
The central trade‑off highlighted in the discussion is between tax revenue gains and long‑term economic performance.
Higher capital gains taxes may increase tax revenue, but they risk discouraging investment, slowing productivity growth, and ultimately weakening real wage growth. At a time when productivity is already under pressure, these effects deserve careful consideration.
A well‑designed capital gains tax system should focus on taxing real economic profits (above a normal rate of return) while preserving strong incentives for saving, investment, and innovation.
Published on 9 February 2026. For further information, please contact us at contact@adepteconomics.com.au or call us on 1300 169 870.